What exactly is independence?
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The term is freely tossed around, but when you get down to it, independence seems to now be a statement against joining any private equity-funded firm.
A core fear of PE is loss of control. The question to ask is, does remaining on your own provide that control? Does a succession team exist that can afford to buy out exiting partners at current market values? Is the firm capable of making the investments in infrastructure, e.g., artificial intelligence, expansion of advisory, development of outsourcing, movement to a global capacity center?
The reality is that market conditions have always controlled the outcome of any firm or business. When COIVID hit, everyone forecasted doom and gloom and businesses were advised to make cuts and hold onto cash. Then the government intervened with the Paycheck Protection Program and as a result many firms had record profit years. Today’s earthshattering changes are private equity and AI, and both appear to have no end in sight.
Independence needs to be redefined as the ability to make the most informed decision that provides the best future step forward for your firm. The battle we are watching play out seems to not always include the complete story on what is the best path forward. Some positions taken are centered around desires and not always logic. When decisions are made based on wants and not needs, that is when the health of a firm or any business begins to enter the danger zone.
Firms need to embrace the adapt-or-die approach to these changes in the accounting profession. Adapting does not mean you need to transact, but you do need to understand if your firm can realistically continue to grow on its own or successfully transition internally. An objective assessment should be conducted at your firm that walks you through every option of independence versus a transaction, and if independence is feasible, take formal steps to create an independence plan that is specific to your firm.
There are many opinions about remaining independent versus private equity in accounting. Unfortunately, those opinions are often made by professionals who have never seen the details of an M&A transaction or been involved in the reasons firms elect to sell or transact.
Firms do not merge or sell only because of the money. They often transact because their succession is not strong enough and infrastructure or other challenges in the firm will present the same problems for the succession team. In every M&A deal from the beginning of time, someone has been unhappy with the change. Unfortunately, those 5% who are not happy are the ones who put the comments on LinkedIn about how the acquirer destroyed culture, career progression, and the firm.
Most firms that transact do it because it is their best path forward. The other side of the coin is if you are a firm with gaps in succession, facing technology investments, and have business development challenges, wouldn’t that be hurting the team you wanted to protect?
Below are the core questions to ask if you want to remain independent.
- Do you have an independence plan? That is, a plan to compete against the firm down the street who was your size and is now part of a large firm. If you think it is great because you are picking up their clients, think twice about why that is occurring. It may be because those clients were burning capacity or underpriced. One thing that occurs in most transactions is a gradual upscaling of the client base. It is the same thing the seller should have done but often did not.
- Can your succession team pay the current market value for your firm? Not the amount your partnership agreement says, which is often one times revenue or the average of your last five years of earnings times a multiple of three. Instead, can they pay $15 million or $20 million for your $10 million firm and put down 60% to 70% in cash at closing?
- Are your partners aligned and willing to make investments in infrastructure? This is vital because they may need to take compensation reductions unless you can find a way to create internal capital to fund those investments.
- Can your succession team sell? As the rainmakers retire the succession team needs to bring in work. If they do not have a track record of that already, it is a red flag that can threaten the independence stance.
What core questions do you ask if you think you need to be acquired? This is easy. Read the questions above and if you have holes in your succession plan, business development issues with the succession team, and are not comfortable selling internally at a lower value paid over a 10-year period versus cash today and stock, then you have two assessments to make.
First, do you have the time, energy, and resources to fix any issues that exist? Second, can you get your succession team to match the market value an outside source is offering? If the answer is no to either of these points, you should explore a transaction process.
What does it take to explore a transaction? Every communication from a firm or group only represents just their option. Most firms do not understand how to identify other options. They just keep reacting to each individual inquiry. As an example, which firm would present a platform opportunity to build around? Would you be better as a tuck-in? In addition, there are many details in a transaction. For example, who keeps the firm’s cash, accounts receivable, work in progress, and capital accounts? How is working capital calculated? How do you get to the right adjusted EBITDA number, the multiple, etc.?
What does it take to explore independence? The realization you have issues, i.e., partner or key staff retirements are coming up, billable hours remain high, you are thin at the manager level, you do not have partner accountability or alignment on the firm’s vision, and are not sure how to address the needed investments that are needed.
Why is there such a strong interest in acquiring firms? It is not a complicated answer: Accounting delivers a repeat, required compliance service. It has historically required significant labor which has material opportunity to automate, and firms are often not extremely aggressive about or capable of delivering additional advisory services. Think of the potential. Firms have a large base of clients and are a trusted source. Their business clients need human resources, technology, wealth management, employee benefits, etc., but the firms often do not offer those services. Imagine the profitability that can come from automation and selling other services to a captive base of clients.
This decision to remain independent or to transact is not an easy one. However, it is essential that every firm does not sit still and wait to see what happens. Standing still is not an option.
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